In 2021, cryptocurrency-related crimes set new records, with a 79 percent increase in total losses of $14 billion. Rug pulls have been among the most popular scams, with over 2.8 billion USD stolen from DeFi protocols victims. Rug pulls can be hard to detect, but there are techniques for detecting and recognizing evil intentions.
The term “rug pull” refers to when cryptocurrency developers or programmers “pull the rug out from under” unwary investors. This can take a variety of forms, and the most prevalent is volatility fraud, which is most commonly seen on decentralized exchanges (DEXs). Rather than using a centralized exchange (CEX), which is held by one central entity, these are administered by consensus with many workstations working together as one system.
Developers can simply, rapidly, and for free develop a coin (a cryptocurrency asset) and publish it for trade on a DEX. CEXs, on the other hand, have a more stringent clearance process, which normally necessitates the disclosure of user information in order to meet KYC/AML regulations.
Because fiat money (such as British pounds, Euros, or USD) cannot be exchanged on DEXs, a new currency minted on one must be associated with another cryptocurrency. The inventors or programmers will be obliged to deposit a number of the linked coin, as well as an equal quantity of their own new coin, into a “liquidity pool,” which will then allow the trade of the coin with the coupled cryptocurrency.
Once a currency is posted on a DEX, builders who aim to rug pull it will frequently create a social media frenzy about the coin and input significant money into the pool. They may also deliberately inflate the value of the coin by buying huge amounts of the currency and slowly selling it while legal traders buy the coins. Practice is known as “pump and dump,” which has recently been challenged by 3 celebrities, notably Floyd Mayweather Jr. and Kim Kardashian.
This action gives the currency a market price and motivates unknowing traders to hurry to purchase the currency as the value rises. There will be a considerable amount of paired cryptocurrencies in the liquidity pool once the currency’s trading activity reaches a high level.
The rug is pulled out from under you at this point: fraudulent developers will take all of the paired crypto assets in the liquidity pools and vanish into the ether, frequently shutting down social media profiles, websites, and other communication channels. As a result, the coin’s price starts dropping to zero, leaving any investors “holding the bag” with no return on their investment. This can happen over several months or in a matter of minutes, as it did in the case of CryptoEats, where the creator was said to have earned 500,000 USD in only minutes!
Malicious developers could also change the operation of tokens to accomplish a rug pull. Legal developers will likely choose a host like ERC20, which comprises a collection of rules that are shared by all ERC20 coins. These rules include a “approve” function that allows token holders to sell their tokens on a DEX for other currencies.
A malicious developer, on the other hand, may utilize the “approve” function to block users from selling the token, only permitting them to buy it, and keeping the right to sell the coin to the developers. Creators can liquidate their holdings after the marketplace has artificially inflated coin prices enough, but users are unable to do so. This is the type of deception at the core of the notorious Squid Game token scam, that left users powerless to sell their coins after the price of the coin climbed from 0.013 USD to 2,861, where the point the creators sold their holdings and vanished.
How Does a Crypto Rug Pull Happen?
DEXes and liquidity pools play a crucial role in Defi being a favored playground for rug pull fraudsters.
For freshly listed tokens, DEXes don’t really require intense audits. Anyone may list their cryptocurrencies and is one of the causes scammers find them so appealing.
Another reason is that liquidity algorithms that operate as market makers for DeFi are decentralized. They don’t have an administrative body to assist trading; instead, smart contracts are used to set and conduct all trade orders.
However, there first has to be liquidity in order for trades to be possible. A large number of investors supply liquidity by locking their cash in multiple cryptocurrency pairs.
By securing a particular amount of funds, anybody can establish a liquidity pool for new trading pairs.
When one liquidity pool is established, the fraudster entices investors to acquire their coins and deposit them in the liquidity pool to gain profits. What strategies scammers employ to entice victims is entirely up to their ingenuity. One of their most popular ruses is to offer extremely high payouts.
As a result, whenever the coin’s price rises, the scammers withdraw the full money trapped in the liquidity pools.
Usually, they use a unique coding to prevent investors from selling their phony coins back to the platforms. Meanwhile, the scam artist is completely able to operate and exchange all forms of digital currency.
How do you avoid a cryptocurrency rug pull?
Investors should be aware of various warning flags to safeguard themselves from rug pulls. Because there are no central bodies to verify coins or projects on DEXs, it’s hard to hunt down the designers of rug pulls. Some even allow creators to list coins without first conducting an audit of the token or project. The decentralized nature of blockchain provides users with considerable anonymity by default, and this is one of its most compelling aspects.
Below are a few warning indicators that investors should be on the lookout for to protect their money against cryptocurrency rug pulls.
The trustworthiness of the persons behind new cryptocurrency initiatives should be taken into account by investors. Is the public aware of the creators and promoters? What kind of track record do they have? Do they seem credible and capable of delivering on their claims if the developer has been doxxed but isn’t well-known?
New and readily fabricated social media pages and profiles should be avoided by investors. The white paper, websites, and other media quality of the initiative should provide indicators as to its general credibility.
It’s possible that unknown project creators are a red indicator. While it is correct that Satoshi Nakamoto, who remains unknown to this day, created the world’s first and biggest cryptocurrency, times have changed.
Liquidity is not restricted
Checking if a coin is liquidity bound is one of the simplest ways to tell the difference between a scam and a legit cryptocurrency. Nothing prevents the project developers from taking all of the liquidity if there is no volatility lock in place on the coin supply.
Time-bound smart contracts, which should endure 3 to 5 years after the token’s initial offering, provide liquidity. While programmers can create their own custom time locking, 3rd-party lockers can offer more security.
Determine the percent of the volatility pool which has been bound by investors. A lock is only useful to the extent that it protects a piece of the liquidity pool. This number, defined as the total value locked, should be around 80 and 100 percent.
Sell order restrictions
A scammer can program a token to limit the ability of some investors to sell but not others. These limits on selling are clear symptoms of a fake project.
It can be hard to detect if there is illegal behavior because selling limits are buried in the code. One approach to check this is to buy a small quantity of the new currency and then try to sell it right away. If it’s difficult to get rid of what you’ve just bought, the project is probably a scam.
With only a few token holders, the value is skyrocketing
Surprisingly large value swings for a new currency should be treated with caution. Sadly, if the currency has no liquidity, this is correct. Price surges in new DeFi tokens are frequently indicators of the “pump” well before “dump.”
A blockchain explorer can be used by traders who are unsure about a currency’s price action to assess the number of currency holders. Because the token has a tiny number of owners, it is vulnerable to market manipulation. The presence of a tiny group of token owners could indicate that a couple of whales are about to dump their holdings, causing massive and rapid damage to the token’s value.
Surprisingly high yields
If something appears to be too great to be true, it most likely is. It’s most likely a Fraudulent scheme if the returns on a new coin appear suspiciously large but don’t seem to be a rug pull.
Although not always symptomatic of a scam, when coins provide an APY in the triple figures, these higher yields usually imply correspondingly high risk.
No external audit
It is currently common procedure for new currencies to be subjected to a professional code audit by a credible 3rd party. Tether (USDT), a controlled stablecoin whose developers refused to declare that it owned non-fiat-backed assets, is one well-known illustration. An audit is particularly important for decentralized currencies since auditing by default is required for DeFi initiatives.
Potential investors, on the other hand, should not accept a developing team’s word for it that an audit was conducted. The audits should be able to be verified by a 3rd party and demonstrate that no malicious code was discovered.
Suddenly, there is a lot of hype.
If a comparatively newer token suddenly surfaces all over social networks and generates a lot of buzzes, it could be a red flag for investors. The excitement usually revolves around a token’s promise or impressive payouts that appear “too good to be true.” Scammers frequently utilize hype to boost the value of a token, which is, in reality, a false and a hoax.
Scammers don’t put extra thought into fraudulent enterprises because they aren’t long-term. This is evident in the foggy whitepaper, which is the essential document for any cryptocurrency project and comprises vision, objectives, and market research. If a project doesn’t offer a whitepaper or gives one that is very vague and comparable to the promotional material, it is best to avoid it.
Deceptive or unrealistic Roadmap
A legitimate crypto project must demonstrate to investors that it has genuine intentions and the ability to carry out its goals. The roadmap of a project provides for the assessment of existing accomplishments as well as future growth goals. A rug pull may be the team’s sole future plan if the plan is amorphous or if there is no plan at all. Call it a red flag if the roadmap proclaims unreasonable future growth plans yet the initiative has yet to achieve anything meaningful.
Listed on DEXes only
Only centralized cryptocurrency exchanges use rigorous listing standards and demand new coins to fulfill their obligations to be listed on DEXes. It’s also a lengthy process, so scammers don’t bother investing their time or money and instead list coins on decentralized markets.
Scammers frequently keep a significant portion of the token allocation for themselves. There is a risk of a rug pull or manipulating the price if a big number of tokens are held in the hands of a few individuals. On platforms like Etherescan or BSCScan, you may analyze the token allocation. Consider this as a red flag when there are few owners but large token quantities in their wallets.
Low trading volume
Trading volume should be between 10 percent and 40 percent of the asset’s market capitalization to be considered healthy. Low liquidity is indicated by a low 24 hr trading volume. If the volume is less than 10%, it indicates that the liquidity pool has insufficient assets. If the idea is still in its early stages or the liquidity isn’t locked in. The legitimate DEXes typically have information on the liquidity of the pools.
To conclude, prior to investing, it is critical to analyze the basics and conduct your own homework. It’s the only way to maintain your skepticism and avoid becoming a victim of a cryptocurrency scam.
While in doubt, go with your gut instinct, according to a rule of thumb. It’s usually better to wait if you have an intense want to acquire something only because your favorite YouTuber advertised a token. Give at least a week to investigate and track its price fluctuations.
Background checks should never be skipped.
The first step in avoiding rug pulls is to fully investigate the cryptocurrency project before participating. Rug pull crypto scams are expected to steal 7.7 billion USD from investors by 2021. These investors believed they were investing in genuine projects, only to see them pulled out from under them.
Never take a project seriously just because it appears to be legitimate. It’s all about reputation, and only trust what you can confirm. The phrase ” Do Your Own Research” is frequently pushed in cryptocurrency circles as a necessity for preventing such frauds.
A cryptocurrency token linked to the popular Netflix series dropped from 2,586 USD to a cent in November 2021. The initiative claimed that an anti-dumping method would be built within the code, rendering the SQUID token unaffected by a big crash. Token owners could only sell if they also held the MARBLE token. Despite this, the unknown creators made off with 3.3 million USD with little to no repercussions.
It is suggested to thoroughly assess new projects and investigate NFT organizations on social media when it relates to NFTs. “You need really do your due research, which involves going to the project’s Twitter and Discord,” referring to a famous instant messaging network where fans may discuss specialized issues like cryptocurrencies. “Once you’ve figured out who the primary team members are, look them up on social media, talk to them on the Discord server, and get involved.” Keep in mind what the project’s social dimension is and what its aim is.”
Simply stated, a rug pull is a modern version of exit frauds, which have existed in the crypto industry since its creation and grew in popularity during the ICO boom. Scammers usually do this by launching a legitimate-looking cryptocurrency project, issuing a token built on a promising proposal, and listing it on DEXes. Fraudsters just withdraw all of the given funds and leave the initiative as the token’s value rises.
Traditional investment assets such as equities, real estate, and commodities are more governed than digital currency. This implies that the con artists will continue to operate in this environment. Furthermore, if cryptocurrency acceptance grows, we may see a rise in cryptocurrency rug pulls in the years ahead. As a result, we must be alert.
Whether it’s a cryptocurrency rug tug or an unpleasant sibling tugging your rug on a cold morning, the sense of wanting to cling on to the rug a tiny bit is the same. We’re sure you don’t want to be startled awake by your rug getting tugged, so be alert!